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How will RBI rate hike impact your mutual fund investments?


You already know about the 40-basis points hike by RBI. You may alsoknow that the banking regulator also raised the Cash Reserve Ratio by 50 basis points. The hike itself may not have surprised most investors, but many were surprised by the timing and the quantum of hike. Most market participants believe that the RBI may go for steep hikes to rein in inflation. So, what do all these developments mean to your mutual fund investments?

To answer the question, it is very important to understand the actions by the RBI yesterday. As you know, the RBI uses its policy rates to signal the rate movement in the economy. So, yesterday’s 40 bps (100 bps = 1%) hike means the interest rates are likely to go up. Next, the RBI also raised the CRR by half percent. CRR is the percentage of deposits banks are mandated to keep with the RBI. Banks do not earn any interest on it.

So, what do these two things mean? One, be ready to pay more for a loan. The RBI is clearly stating that the interest rates are likely to go up by raising the policy rate. Two, by increasing the CRR it is tightening or sucking out the excess liquidity in the banking system. Again the RBI is saying that easy money conditions are coming to an end. Sure, we didn’t have zero or near zero interest rates.

Next, let us move to your equity mutual fund investments. As said earlier, loans are going to be costly. Companies that borrow a lot of money are going to be under pressure, as they will pay more for loans. Some of them may also find it difficult to get a loan. Under such conditions, very large companies that have very little debt are likely to do well. It means your large cap mutual funds are likely to perform better in the near future.

If you have investments in small cap companies, be prepared to face some volatility and losses. If your mid cap scheme also may face rough weather. Sadly, most of these companies also face corporate governance issues during such trying times. So be very careful.

Also, scale down your return expectations from equity this year. Be very happy with positive returns. Also, don’t panic if your schemes are in the red. Don’t panic and continue with your regular investments. It’s time to curb speculative or aggressive investments.

Now, we will move to your debt mutual fund investments. As you know, rising interest rates are bad news for debt mutual funds, especially long-term debt funds and government bond funds. When rates go up, prices of bonds fall. This is because most investors would wait for new bonds that will pay more for loans. Stick to short term debt funds. If you are investing in debt funds for your three or slightly longer goals, continue with your investments in corporate bond funds, banking & PSU funds, etc. Sure, these short term funds may face short term volatility, but they may recover in time.



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